(This is a highly-abbreviated version of a full SumZero report republished with the author's consent. Vast details regarding the thesis have been omitted.)
Contributor: Jonathan Heck
Source: J. Heck Investments. New York, NY.
Recommendation: Short Shares of iShares FTSE/Xinhua China 25 Index (NYSE: FXI)
Timeframe: 1 to 2 Years
Recent Price: $38.00
Target Price: $25.00
Quick Thesis and Philosophical Overview
Over 2 years ago I published a research piece (still posted on SumZero) laying out my expectations for an eventual fixed asset investment crash in China (yes, before Chanos). This thesis has become increasingly popular in terms of broader acceptance and public attention.
The thesis is fairly unique and targeted at addressing specific underlying dynamics and the misunderstood bull arguments (social housing, government use of fiscal/monetary policy, notion of a “soft landing”, etc…).
Some of this research is entirely novel and quite powerful (specifically the use of input output tables to quantify the feedback loops in China and map out how a country with under 10% of global GDP consumes over 50% of many global resources).
The pixie dust behind China’s economy is little more than poorly allocated capital, the vast majority of which has driven a property, infrastructure, and factory bubble on a scale that leaves little doubt as to the final resolution.
There is only one scenario that does not further inflate the imbalances in the economy...fixed asset investment in China must decline precipitously. The magnitude of the distortions in the Chinese economy and the fact these imbalances permeate much of the economy make it practically inconceivable that a correction in the real estate market can be orderly and contained or that China can slowly decelerate in a ‘soft landing’ scenario.
The sobering truth is that China’s economy is bound by the same laws of economics that underlie the rest of the world and, in fact, is grossly imbalanced and headed towards a significant, inevitable downturn.
Further, the structural export growth from the exploitation of its main competitive advantage, a massive low‐cost labor force, has subsided, and growth in domestic consumption is grossly inadequate to drive current expectations (and in any case correlated to growth rates in the rest of the economy). This analysis goes beyond a recap of our original analysis on China’s imbalances from 2009, which has now become popularized by Chanos and other China bears.
Don’t be fooled into thinking that China will become the first country in history to win an arm wrestling
match against the invisible hand.